Missed opportunity?
Missed opportunity?
This is a problem that most small company leaders have. I fell victim to it once. And, I will share my personal experience as well as this recent experience with a firm where I served as a financial manager (interim CFO).
I worked with these people three days a week - Monday, Tuesday, and Thursday. And, this week in question, I had to deal with a licensing issue that had been neglected by the entrepreneur. (Let's call him Ernest.) One that will shut us up. And, for most of Monday and Tuesday, I had to shuttle between different offices to make sure we could get a clean bill of health and get our license renewed. Which meant I wasn't in the office at all for the first part of the week.
I took a walk on Thursday morning and saw complete chaos. It seems that one of the firm's employees, who had an MBA (at least that was the scuttlebutt—but during the year I worked with him, there was no evidence that whatever business acumen he has) had convinced Ernst that a prime money-making opportunity. And, both of them (MBA and Ernest) started "investing" at that point.
(As an aside. As the firm's financial manager, Ernst should have talked to me at this point before jumping in with both feet. Ernst didn't even talk to the firm's investors at this point. (Oh, sure, Ernst might be the largest stockholder—but he's not the majority stockholder. Not exactly "best practices.")
This meant that during the busiest season of the year for our firm, we were scrambling to deliver our usual products—and things we never deliver—to two clients who were attending a major convention. were handling Which meant we needed to buy even more inventory—most of which would be COD, as we had no long-term arrangements with these vendors)—for our cash-strapped firm, when we Were to get ¼ - 1/3 of your total gross. Income for the year. (This is why we were cash poor—we were loaded on inventory to take advantage of our big season.)
Oh, and we don't have that many employees. And, no trucks—since we use services like FedEx and UPS to deliver to our customers. And, this big "opportunity" required us to deliver directly to them. Approximately 20,000 pounds were shipped to two locations.
And, it gets better. It seems that these two vendors asked for "special pricing" for their larger orders. 10 to 20% off our normal markup. (We don't really do a markup—we divide our raw material cost by 40%—which means we multiply the raw material cost by 2.5 to get the selling price.)
There is a big difference between markup and margin. If you have a 40% margin (hypothetically), that means your direct costs—raw materials, labor, and shipping— are equal to 60% of your gross revenue. And, let's assume you're doing really well and making a 10% profit. That means for $100 in sales, you clear $10 in profit after spending $60 on raw materials. So, giving a customer a 10% or 20% price cut means you're only making $80 or $90 in revenue. So, you can see – there is no profit on this sale. There may be a loss.
Now, let's look at the concept of markup. If we spend $50 on raw materials and divide the cost by 40% for markup, we are selling the item for $125. Yes- gross income is higher in this situation. But, even with that higher revenue, we were still only making a 10% profit—or $12.50. So, if we cut our selling price by 10% or 20%, that means we're cutting our revenue by $12.50 to $25.00—which means we're definitely losing money.
And, it gets better. Because we had to rent a truck. We had to work longer hours. And, we had to use our marginal cash for those sales—leaving less cash for our general sales. Oh—and no one at the big meeting we were desperate to supply would actually know who supplied them. Therefore, any new business prospects were close to zero!
And, the piece de resistance? These vendors did not pay us for delivery, as all our customers do. No, we had to wait for their money. Which means less money for inventory needs for our regular customers.
Now, for my personal story. One of our businesses was the very high margin, operating in the medical services line. It was our hope—and our corporate mission—to expand that market segment from 1% to 5%, 10%, 100%—and where we would have about 50% market share or more. And, in the first three years of operation, we increased our market segment by about 15% - 90% of that segment came to us.
My operational team (including me!) thought we could grow the segment even faster if we provided another (obviously inferior) product choice. Then, we can work within hospitals and clinics to convince them to switch to better treatment modes. This meant that we could quickly get them used to our treatment regimens without this approach.
Our board (who, by the way, were not investors in the firm) reminded us that this was a bad business. Despite Thunderbird prices, we were clearly the Rolls-Royce of the market. (In case I lost you with that analogy, our product offering was the best therapy out there--and our prices were a little higher than the less-profitable choices--more than what they were paying, but not by much. ).
And, our board members reminded us that we are still a small company. One that had a "big" reputation. And, we'll never build that reputation back to its glory days if we chase every sale and not in the right places.
Yes, we trusted our board. thanks. Kudos to Arthur Lepper and the departed Bob Boyle and Bill Weissert for keeping us connected to our mission and vision.
I didn't write this to show you that getting sales that cost you money is bad. Because, if we didn't discount those customers, you'd think it was a good idea. Because we could make money on that sale. Just like our firm would have made some money selling conventional therapy.
But, by adding the two stories, you should see that the whole concept is wrong. This potential sale was not consistent with our mission statements. They were not in line with our operational plans. They didn't even trust our normal product lines. We had to expand everything to take advantage of these "opportunities". That includes making it harder for us to accomplish our goals—providing our core customers with the best products when they want them, at prices and service levels—that keep them coming back.
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